QBA341SUMMER I, 2014/15

SOLUTIONS TO PRACTICE EXERCISES

Chapter 3: Decision Analysis

Question 1a) MaximaxThe decision is selected that will result in the maximum of the maximum payoffs. This is how this criterion derives its name--the maximum of the maxima. Themaximax criterionis very optimistic. The decision maker assumes that the most favorable state of nature for each decision alternative will occur. Thus, for this example, the company would optimistically assume that good competitive conditions will prevail in the future, resulting in the following maximum payoffs and decisions:

Decision: Maintain status quo

b) MaximinThemaximin criterionis pessimistic. With the maximin criterion, the decision maker selects the decision that will reflect themaximumof the minimumpayoffs. For each decision alternative, the decision maker assumes that the minimum payoff will occur; of these, the maximum is selected as follows:

Decision: Expand

c) HurwiczA compromise between the maximax and maximin criteria. The decision maker is neither totally optimistic (as the maximax criterion assumes) nor totally pessimistic (as the maximin criterion assumes). With theHurwicz criterion,the decision payoffs are weighted by acoefficient of optimism,a measure of the decision maker's optimism. The coefficient of optimism, defined as, is between 0 and 1 (i.e., 0<